How Moving Into Your Rental Property Can Lower Your Taxes

Capital gains when moving into a co-owned property

When you change the use of a property—from a rental to your principal residence—the tax system treats that change as if you sold the property and immediately bought it back at its fair market value. That deemed transaction can create a capital gain if the property’s value has increased since you acquired it. If you previously claimed depreciation on the building (capital cost allowance), those prior deductions are generally brought back into income through recapture in the year of the change of use.

However, in many cases when a rental becomes a principal residence you can elect to defer the capital gain under the relevant tax rules. The election is not available if you or your spouse or common-law partner ever claimed capital cost allowance on the property. If CCA has not been claimed, you can elect to defer recognition of the gain until a later disposition such as a sale.

How to defer capital gains

To claim the deferral you must file an election with your tax return. The election is typically made in a written form attached to the return; while there’s no strict prescribed format, the letter should identify the property and specify that you are electing the relevant provision of the Income Tax Act to defer the gain. You do not necessarily have to make the election in the year you move in — the election can often be filed as late as the due date of your tax return for the year in which you sell, or earlier if the tax authority requests it.

In addition, you may be able to designate the property as your principal residence for up to four years before you actually moved in, provided you didn’t designate another property as your principal residence for those same years. This transitional rule can reduce the portion of any capital gain that arose while the home was used as a rental.

If you make the proper election, you can potentially defer recognition of the capital gain up to the time of sale, and in some circumstances until death, since death triggers a deemed disposition that may crystallize capital gains. Remember, though, if you have ever claimed CCA the recapture rules will apply and you won’t be able to use the election.

One practical consequence to note is that mortgage interest on debt used to purchase a rental property is typically deductible against rental income. Once the property is converted to personal use as your principal residence, that interest generally ceases to be deductible because the debt is now associated with a personal-use asset.

How joint ownership affects capital gains

Co-ownership adds several layers of complexity. First, you should confirm the exact form of ownership recorded on title by checking the deed or speaking with the real estate lawyer who handled the purchase. There are two common forms of joint ownership:

• Joint tenancy with rights of survivorship — ownership passes automatically to the surviving co-owner(s) on death, and it is commonly used by spouses who want an automatic transfer without probate.
• Tenants in common — each owner holds a distinct share that can be dealt with separately during life or testamentary disposition; this is often used when co-owners are friends, business partners, or non-spouses who want control over their individual shares.

If you prefer to control what happens to your share during your lifetime or after death, tenants in common is usually the better structure. If title simply lists two names without clear wording, the default legal interpretation can vary by jurisdiction, so obtaining a clear statement from a lawyer or title search is important.

Beyond title form, practical questions matter: if you move into a home that is 50% co-owned by a colleague, will you pay rent or compensate them for their share of occupancy? Who is responsible for mortgage payments, property taxes, insurance, maintenance and renovations? How will repair costs and capital improvements be handled? Clarifying these points in writing can prevent disputes and clarify who is entitled to future tax benefits or responsible for tax consequences.

Your co-owner will continue to accumulate their own deferred capital gain on their share while they remain an owner. Converting the property to your principal residence does not automatically remove their tax exposure unless they sell or otherwise dispose of their interest.

Consider also planning for incapacity and what will happen if one of you can no longer manage the property. A co-ownership agreement, powers of attorney, and clear estate planning can help avoid unexpected outcomes.

For many people in your situation, buying out the co-owner so you own the property outright simplifies both practical and tax matters. If a buyout isn’t possible, document agreements clearly and consult both a real estate lawyer and a tax advisor before making the change.

Read more from Jason Heath:

• How spouses with joint accounts should claim capital losses
• Should RRIF withdrawals be based on the younger spouse’s age?
• How much to take out of your RRSP in your 60s
• What are the tax implications of selling U.S. real estate?